Sunday, September 24, 2006

Loss in translation

I talk to a fair number of reporters as a local go-to guy for economic things. I also co-author the Quarterly Business Report for the St. Cloud Area. The report is in essence two halves -- one is a survey of business leaders, the other a statistical model. I am largely responsible for the statistical model, as that's my training and a fair part of my teaching assignment.

The St. Cloud Times is a partner in publishing the report, and every quarter it comes out I am interviewed for its contents without any real knowledge of how they'll play the story. And when I did this interview this Friday, I admit I was nervous about how this would play, as it's a different forecast than any we've given in four years. The writer of the story, Dawn Peake, is someone we've worked with for two years and I think she's a good reporter, and the story is fine; as far as I'm concerned, if reporters misstate what I say it's more likely I didn't say it right. But to find yourself attached to a headline story is unnerving, particularly when it exaggerates what you said:

"We've really made no progress compared to our long-term trends," said King Banaian, co-author of the report and chairman of the economics department at St. Cloud State University. "We've just been bumping along."

Local economists are cautious about what the next six months will bring but are not ready to say recession yet. Banaian said economic conditions suggest that the area is clear of a recession until at least March.

"We don't feel like the economy has turned south; it just has turned east � or west," said Rich MacDonald, co-author of the report and director of the Center for Economic Education.

I don't know who wrote the headline -- I'm quite sure it wasn't Peake -- but it's really too strong when compared to those three paragraphs.

To really grasp what we're talking about means you understand uncertainty and risk. Here's the whole report, and you can judge for yourself. We tried to give the impression that what's happened is an increase in risk of recession. To understand that, imagine you had five possible outcomes from an investment, expressed in terms of your rate of return: -3%, 1%, 5%, 9% and 13%. And let's suppose the chances of each outcome are currently 5%, 15%, 60%, 15%, and 5%, so that the expected value of the investment's rate of return is 5%. Now we enter a period of uncertainty, and while none of the possible outcomes change, the chances go to 10%, 20%, 40%, 20% and 10%. The expected value of the investment's rate of return is still 5%, but the probability of making a loss has doubled. Doesn't that affect investment? How do you represent that, and how do you report that?

That was what we tried to get out there. Some fellow* in the comments on the Times article takes a shot at me:

This is why an economist is not a businessman. If a businessman waited for perfect conditions to stick his/her neck out a little, they would never get out of bed. And while they hunker down, some other businessman will seize the opportunity.

King Banian is generalizing...and so am I.

Of course I am -- that's what I get paid to do. And of course those who take risks and guess the economy correctly will get the gains. But I don't think it's right for a forecaster to encourage people to ignore additional risk. My job is to point out the increased risk. What that does is increase the option value of waiting on an investment -- which I know are the words I used in the interview -- which should make one rationally less likely to investment.

You can read the rest of the story to see what MacDonald and I think about the local economy, and you will no doubt here more about it locally in the next couple of days. That kind of headline leaves a mark, and I am sure I'm going to catch hell from a few people.

* -- I found it humorous later on the same fellow says "is hoping with lower energy prices this fall, and leveling off of interest rates...maybe even a slight decline, things will pick up by xmas and for 2007." I guess businessmen tell other businessmen to take a punt; economists don't.